Macro Highlights: The Swiss franc and the yuan are on diverging paths

Macro Highlights
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11/23/2016

Whereas an upsurge in the value of the Swiss franc might prompt the Swiss National Bank to take new policy measures, the Chinese yuan has weakened against the dollar since the election of Donald Trump. The yuan’s depreciation has been moderate so far but could gain pace more than expected. These points are analysed by economist Matthias van den Heuvel, a member of our Economic Research team.

Before the US elections, Andrea Mächler, a member of the governing board of the Swiss National Bank (SNB), confirmed that the SNB was ready to intervene to prevent the franc was rising further. Following Donald Trump’s victory, the franc did indeed rise. The EUR/CHF exchange rate dropped below the unofficial floor of 1.08, which is broadly considered the level under which the SNB intervenes on the currency market. Yet, the EUR/CHF exchange rate has remained below 1.08 since 8 November and even briefly reached 1.068 on 18 November, its lowest level since August 2015.

With the Swiss franc so strong, the SNB could step in, favouring foreign currencies purchases rather than a lowering of its benchmark rate, as it did following the Brexit referendum. This may be what SNB Vice Chairman Fritz Zurbrügg was referring to when, on 16 November, he emphasised the SNB’s determination to intervene on the currency markets if necessary. This preference for acting through the currency markets is justified by the impact of negative interest rates on Swiss manufacturing, savers and pension funds.

However, the SNB could use other monetary policy tools if future political developments in the Eurozone led to additional upward pressure on the Swiss franc. This risk can be seen in the 4 December constitutional referendum in Italy, where surveys currently point to a defeat by Prime Minister Renzi. Mr Renzi vowed to step down if he lost the referendum, which aims at giving the country more political stability by simplifying the bicameral system. The political uncertainty resulting from a defeat could indeed increase demand for the franc. If the franc were to remain below 1.08, the SNB could be forced to lower its benchmark rate, since that would mean that its operations on the currency markets fell short of the mark.

The yuan has weakened against the US dollar, hitting its lowest level in eight years. It is coming under downward pressure following the election of Donald Trump, given the uncertainty surrounding the scope of possible protectionist measures and the nature of Chinese-American relations. The currencies of the United States' other trading partners, including South Korea, Taiwan and the Philippines, have come under a similar amount of pressure. Still, the yuan remains stable relative to its benchmark currency basket, whose value depends on China’s main trading partners (see right-hand chart). Monetary policy advisors have highlighted the risk of significant capital flight from China if the yuan were to break through the psychological threshold of 7.0. If this were to happen, the People’s Bank of China would very likely have to support the yuan through currency market operations.

We still expect the yuan to depreciate, although the moderate decline could now pick up speed. Under our forecasts, it could reach 7.0 dollars by the end of the first half of 2017.

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